## Facts

- North End Timber Productions LLC (NET) filed Chapter 11 bankruptcy in 2006; the case was converted to Chapter 7 in 2007.
- A fire damaged or destroyed NET’s mill equipment and related property, resulting in $150,000 in insurance proceeds.
- Three secured creditors claimed the proceeds based on perfected security interests in NET’s personal property and equipment:
  - Three Rivers Bank of Montana (TRB) perfected first.
  - Jobs Now, Inc. (JNI) perfected second.
  - Johnson Brothers Contracting, Inc. (JBC) perfected third.
- The insurance policy listed TRB and JNI as loss payees. JBC’s security agreement required NET to name JBC as a loss payee, but JBC was not listed on the policy.
- TRB and JBC executed a subordination agreement under which TRB agreed to subordinate its security interest in identified machinery and equipment to JBC.
- The parties agreed that $104,000 of the fire loss was attributable to equipment listed in the subordination agreement; the remaining loss related primarily to wiring and support structure not listed in the agreement.
- In the adversary proceeding, the parties advanced competing distribution theories:
  - TRB argued it should receive all $150,000 based on first priority and its view that it did not subordinate its interest in insurance proceeds; alternatively, it argued any subordination applied only up to $104,000.
  - JNI argued that if TRB remained first, JNI should take next; but if TRB subordinated to JBC, JNI should move into first position ahead of JBC.
  - JBC argued the subordination agreement placed it first as to the collateral covered by the agreement and sought at least $104,000 (and argued it could be entitled to more), taking no firm position on the remaining $46,000.

## Issues

1. Whether TRB’s subordination agreement in favor of JBC could place JBC ahead of JNI with respect to the insurance proceeds, even though JNI was not a party to the agreement.
2. Whether the subordination agreement applied to insurance proceeds attributable to the listed machinery and equipment, and if so, whether it was limited to the agreed $104,000 portion of the loss.
3. What effect, if any, JBC’s absence as a named loss payee had on its right to claim the insurance proceeds as Article 9 proceeds of collateral.

## Decision

- The court enforced the TRB–JBC subordination agreement under 11 U.S.C. § 510(a) according to its terms.
- The court rejected JNI’s argument that it automatically moved into TRB’s priority position upon TRB’s subordination; instead, the agreement could reorder priority so that JBC took ahead of JNI as to the subordinated collateral and its proceeds.
- The court treated the insurance payment as Article 9 proceeds of the destroyed collateral and applied the subordination agreement to the proceeds attributable to the listed equipment.
- Based on the parties’ stipulation tracing $104,000 of the loss to equipment covered by the subordination agreement, the court awarded JBC first priority to that portion of the proceeds.
- As to the remaining proceeds (approximately $46,000) attributable to property not covered by the subordination agreement, the court applied normal Article 9 priority: TRB first, then JNI, then JBC.
- The court concluded that JBC’s lack of loss-payee status did not defeat its secured-claim priority in proceeds within the bankruptcy distribution; loss-payee status primarily concerns direct rights against the insurer, not lien priority among secured creditors once proceeds are in the estate.

## Legal Principles

- Under 11 U.S.C. § 510(a), a subordination agreement is enforceable in bankruptcy to the same extent it is enforceable under applicable nonbankruptcy law.
- A senior creditor’s contractual subordination in favor of a junior creditor may reorder priority so the junior creditor is paid ahead of an intervening creditor with respect to the collateral and proceeds covered by the agreement; the intervening creditor does not automatically advance in priority merely because the senior creditor agreed to subordinate.
- Insurance payments for damaged or destroyed collateral are generally “proceeds” under UCC Article 9, and a security interest in collateral continues in identifiable proceeds, subject to any valid subordination arrangement.
- The scope of subordination turns on the agreement’s terms and the collateral it identifies; when proceeds can be traced to covered collateral (here, by stipulation), the subordination applies to that portion.
- Loss-payee designations affect rights under the insurance contract, but they do not by themselves determine Article 9 priority among competing secured creditors to proceeds held for distribution in bankruptcy.

## Conclusion

The bankruptcy court enforced TRB’s subordination agreement so that JBC received first priority in the insurance proceeds attributable to the listed equipment ($104,000), ahead of both TRB and intervening lienholder JNI, while TRB (and then JNI) retained priority in the remaining proceeds not tied to subordinated collateral.


In re North End Timber Productions LLC, 2007 WL 4468706 (2007)